Nally, Inc., is considering a project that will result in initial aftertax cash

Question

Nally, Inc., is considering a project that will result in initial aftertax cash savings of $7 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt-equity ratio of .69. a cost of equity of 13.4 percent, and an aftertax cost of debt of 6.4 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +3 percent to the cost of capital for such risky projects. Calculate the WACC. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) What is the maximum cost Nally would be willing to pay for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Weight od debt = .69/ (1+.69) = .69 / 1.69 = .4083

Weight of equity = 1 -.4083 = .5917

WACC = (6.4 * .4083 ) +(13.4 * .5917)

              = 2.61+ 7.93

             = 10.54%

WACC for this project = 10.54 + 3 = 13.54%

b) Present value = cf 1/ (WACC -G)

                                 = 7 / (.1354 - .03)

                               = 7 / .1054

                               = $ 66.41 million

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